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| Notes to the Consolidated Financial Statements |
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(CHF thousands, except share and per share amounts)
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| Note 1. Description of business and summary of significant accounting policies |
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Actelion Ltd (“Actelion” or the “Group”), a biopharmaceutical company headquartered in Allschwil, Switzerland, discovers, develops and commercializes innovative low molecular weight drugs for high unmet medical needs.
Basis of accounting
The Group’s consolidated financial statements have been prepared under accounting principles generally accepted in the United States of America (“US GAAP”) and are presented in Swiss francs (“CHF”). On October 27, 2003, the Group announced its intention to adopt US GAAP for its financial reporting and to restate all periods since inception. All periods presented are accounted for under US GAAP. Prior to the conversion, the Group’s consolidated financial statements were prepared in accordance with International Financial Reporting Standards including International Accounting Standards and Interpretations as issued by the International Accounting Standards Board.
Use of estimates
The preparation of financial statements in conformity with US GAAP requires management to make judgments, assumptions and estimates that affect the amounts reported in the financial statements and accompanying notes. On an on-going basis, management evaluates its estimates, including those related to revenue recognition for contract revenue, stock based compensation, purchase accounting and impairment. The Group bases its estimates on historical experience and on various other marketspecific assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ significantly from these estimates.
Principles of consolidation
The consolidated financial statements include the accounts of the Group and its wholly-owned subsidiaries as well as affiliated companies in which the Group has a controlling financial interest and exercises control over their operations. All material intercompany transactions and balances have been eliminated in consolidation. Investments in affiliated companies which are 50% or less owned and where the Group exercises significant influence over operations are accounted for using the equity method.
Consistent with our policy for purchases or sales of equity by an investee, at the time a less than wholly-owned consolidated subsidiary sells its stock to unrelated parties at a price different than its book value, the Group’s net investment in that subsidiary changes. The Group records the resulting increase or decrease in its net investment as a gain or loss to the Group’s additional paid-in-capital.
Segment information
Statement of Financial Accounting Standards (“SFAS”) No. 131, ’’Disclosures about Segments of an Enterprise and Related Information’’, establishes standards for reporting information on operating segments in interim and annual financial statements. The Group’s chief operating decision-makers review the profit and loss of the Group on an aggregate basis and manage the operations of the Group as a single operating segment.
Accordingly, the Group operates in one segment.
Revenue recognition
Product Sales
The Group recognizes revenue from product sales when there is persuasive evidence that an arrangement exists, delivery has occurred, the price is fixed and determinable, and collectibility is reasonably assured. Allowances are established for estimated uncollectible amounts, product returns and discounts. Generally, the Group ships products to its customers fully insured with shipping terms of DDU destination point.
Contract Revenue
Contract revenue includes license fees and milestone payments associated with collaborations with third parties. The Group recognizes revenue from collaborative agreements when the services are performed and collectibility is reasonably assured, revenue from non-refundable, upfront license fees and performance milestones where the Group has continuing involvement is recognized over the estimated performance or agreement period, depending on the terms of the agreement. The recognition of revenue is prospectively changed for subsequent changes in the development or agreement period. Revenue associated with performance milestones where the Group has no continuing involvement or service obligation is recognized upon achievement of the milestone. Payments received in excess of amounts earned are classified as deferred revenue until earned.
Shipping and handling costs
The Group recognizes expenses relating to shipping and handling costs in cost of goods sold.
Research and development
Research and development expense consists primarily of compensation and other expenses related to research and development personnel; costs associated with pre-clinical testing andclinical trials of the Group’s product candidates, including the costs of manufacturing the product candidates; expenses forresearch and services rendered under co-development agreements; and facilities expenses. All research and development costs are charged to expense when incurred.
Payments made to acquire research and development assets, including those payments made under licensing agreements, that are deemed to have an alternative future use or are related to proven products are capitalized as intangible assets; otherwise, they are expensed as research and development costs. For further information on payments made under the Group’s licensing agreements refer to Note 5, “Licensing Agreements”.
Advertising costs
The Group expenses the costs of advertising, including promotional expenses, as incurred. Advertising expenses were CHF 46.3 million in 2004 and CHF 37.0 million in 2003.
Patents and trademarks
Costs associated with the filing and registration of patents and trademarks are expensed in the period in which they occur.
Taxes
The Group uses the liability method to account for income taxes as required by SFAS No. 109, “Accounting for Income Taxes”. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities, and are measured using enacted tax rules and laws that will be in effect when differences are expected to reverse. The Group records valuation allowances to reduce deferred tax assets to the amount that is more likely than not to be realized. Significant estimates are required in determining income tax expense and benefits. Various internal and external factors may have favorable or unfavorable effects on the future effective tax rate. These factors include, but are not limited to, changes in tax laws, regulations and/or rates, changing interpretations of existing tax laws or regulations, future levels of capital expenditures, and changes in overall levels of pretax earnings.
Earnings per share
Basic earnings per share is computed using the weighted average number of common shares outstanding during the period. Diluted earnings per share is computed using the weighted average number of common and diluted common equivalent shares outstanding during the period using the treasury stock method for options, unless amounts are anti-dilutive.
Dividends
The Group may declare dividends upon the recommendation of the board of directors and the approval of shareholders at their annual general meeting. Under Swiss corporate law, the Group’s right to pay dividends may be limited in specific circumstances. The Group has not paid any cash dividends since inception and does not anticipate a dividend in the near to medium term.
Cash and cash equivalents
The Group considers all highly liquid investments with an original maturity of three months or less when purchased to be cash equivalents. Additionally, the Group includes all amounts held in money market funds as cash equivalents.
Marketable securities
The Group categorizes marketable securities as either “available-for-sale” or “held-to-maturity.” Available-for-sale securities are carried at fair value with unrealized gains and losses recorded as a separate component of shareholders’ equity. Held-tomaturity securities are carried at amortized cost. Dividends and interest income are accrued as earned. Realized gains and losses are determined on an average cost basis. The Group reviews marketable securities for impairment whenever circumstances and situations change, such that there is an indication that the carrying amounts may not be recovered. Securities with unrealized losses for more than six months are presumed to be impaired, absent compelling evidence to the contrary. In addition, securities with unrealized losses for less than six months may be deemed impaired in certain circumstances.
Derivative instruments
A significant portion of the Group’s operations is denominated in foreign currencies, principally in U.S. dollars and Euros. The inherent exposure may adversely impact the Group’s net income and net assets. The Group uses derivatives to partially offset market exposure to fluctuations in foreign currencies. The Group records all derivatives on the balance sheet at fair value. The Group’s derivative instruments, while providing effective economic hedges under the Group’s policies, do not qualify for hedge accounting as defined by SFAS No.133, “Accounting for Derivative Instruments and Hedging Activities”. Changes in the fair value of any derivative instruments are recognized immediately in other financial income (expense) in the consolidated statements of operations. See Note 10, “Investments” for further information on the Group’s accounting for derivatives.
The Group does not regularly enter into agreements containing embedded derivatives. However, when such greements are executed, an assessment is made of any embedded derivative based on the criteria outlined in SFAS No. 133 to determine if the derivative is required to be bifurcated and accounted for separately. See Note 10, “Investments” for further information on the Group’s accounting for these embedded derivatives.
Accounts receivable
The Group maintains an allowance for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. If the financial condition of the Group’s customers were to deteriorate, resulting in an impairment of their ability to make payments, an increase to the allowance might be required, which could affect future earnings.
Inventories
Inventories are stated at the lower of cost or market with cost determined by the first-in first-out (FIFO) method. Inventories consist of intermediaries and finished products. If inventory costs exceed the expected market value due to obsolescence or unmarketability, a reserve is recorded for the difference between the cost and the market value.
Property, plant and equipment
Property, plant and equipment is recorded at historical cost less accumulated depreciation.
Depreciation expense is recorded utilizing the straight-line method over the estimated useful life of the asset. Assets are written down to their estimated residual value. Leasehold improvements and assets acquired under capital leases are amortized using the straight-line method over the shorter of the lease term or estimated useful life of the asset. Assets acquired under capital leases in which title transfers to the Group at the end of the agreement are amortized over the useful life of the asset. Expenditures for maintenance and repairs are charged to expense as incurred.
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The depreciation periods in years are as follows:
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| Group of assets | | Useful life | |
| Computers | | 3 years | |
| Furniture and fixtures | | 5 years | |
| Laboratory equipment | | 5 years | |
| Leasehold improvements | | 5 to 10 years | |
| Building | | 2 to 25 years | |
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The carrying values of the Group’s long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the asset may not be recoverable. Specific potential indicators of impairment include: - a significant decrease in the fair value of an asset;
- a significant change in the extent or manner in which an asset is used or a significant physical change in an asset;
- a significant adverse change in legal factors or in the business climate that affects the value of an asset;
- an adverse action or assessment by the U.S. Food and Drug Administration or another regulator;
- an accumulation of costs significantly in excess of the amount originally expected to acquire or construct an asset; and
- operating or cash flow losses combined with a history of operating or cash flow losses or a projection or forecast that demonstrates continuing losses associated with an incomeproducing asset.
Should there be indication of impairment, an assessment will be made by comparing the estimated future cash flows expected to result from the use of the asset and its eventual disposition to the carrying amount of the asset. In estimating these future cash flows, assets are grouped at the lowest level for which there are identifiable cash flows that are largely independent of the cash flows generated by other asset groups. If the sum of the expected future cash flows (undiscounted and without interest changes) is less than the carrying amount of the asset, an impairment loss, measured as the excess of the carrying value of the asset over its fair value, will be recognized. The cash flow estimates used in such calculations are based on management’s best estimates, using appropriate and customary assumptions and projections at the time.
Goodwill and intangible assets
Goodwill represents the excess of purchase price over the fair value of net assets acquired in a business combination. Pursuant to SFAS 142, “Goodwill and Other Intangibles”, goodwill is not amortized and is regularly reviewed for impairment.
Intangible assets consist primarily of acquired existing licenses and internal use software, which is amortized on a straight-line basis over the economic lives of the respective assets, estimated at 11 and 3 years, respectively.
Stock-based compensation
The Group accounts for stock-based awards to employees and directors using the intrinsic value method in accordance with APB No. 25, “Accounting for Stock Issued to Employees.” Accordingly, the Group does not recognize compensation expense for employee stock options granted with an exercise price equal to the market value of the underlying common stock at the date of grant. In instances where an option is granted to an employee with an exercise price below the market value of the underlying common stock at the date of grant, the option is expensed in accordance with Financial Accounting Standards Board (“FASB”) Interpretation Number 28, “Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans an interpretation of APB Opinions No. 15 and 25”. For purposes of disclosures pursuant to SFAS No. 123 as amended by SFAS No. 148, the estimated fair value of options is amortized to expense over the options’ vesting period. Equity instruments issued to non-employees are measured at fair value over the period of performance using the Black-Scholes option pricing model.
Comprehensive loss
Comprehensive loss is comprised of net loss and other comprehensive income (loss). Other comprehensive income (loss) includes unrealized gains and losses on available-for-sale securities and currency translation adjustments. Comprehensive income (loss) for the years ended December 31, 2004 and 2003 has been reflected in the consolidated statement of changes in shareholders’ equity.
Foreign currency exposure
Income, expense and cash flows of foreign subsidiaries are translated into the Group’s reporting currency at quarterly average exchange rates and the corresponding balance sheets translated at the period-end exchange rate. Exchange differences arising from the translation of the net investment in foreign subsidiaries and long-term internal financing are recorded, net of tax, in “currency translation adjustment” in shareholders’ equity. Foreign currency transactions are accounted for at the exchange rates prevailing at the date of the transactions. Gains and losses resulting from the settlement of such transactions and from the translation of monetary assets and liabilities denominated in foreign currencies are recognized in the subsidiary’s statement of operations in the corresponding period.
Interest rate risk
Interest rate risk arises from movements in interest rates, which could have adverse effects on the Group’s net income or financial position. Changes in interest rates cause variations in interest income and expenses on interest-bearing assets and liabilities. In addition, they can affect the market value of certain financial assets, liabilities and instruments.
Recent accounting pronouncements
On December 15, 2004, the Financial Accounting Standards Board (FASB or the “Board”) released its final revised standard entitled FASB Statement No. 123R, Share-Based Payment (FAS 123R), the key requirement of which is that a public entity measure the cost of equity based service awards based on the grantdate fair value of the award (with limited exceptions). Cost will be recognized over the period during which an employee is required to provide service in exchange for the award or the requisite service period. The standard provides guidance on how to account for changes in the fair value of the award, which models may be used to assess fair value and the tax effect of such awards. It also requires additional disclosure requirements to help understand the nature of share-based payment transactions and the effects of those transactions on the financial statements. The standard is effective as of the beginning of the first interim or annual reporting period that begins after June 15, 2005.
On December 15, 2004 the FASB issued Statement No. 153 (FAS 153), Exchanges of Nonmonetary Assets – Accounting Principles Board Opinion No. 29, Accounting for Nonmonetary Transactions (APB 29). FAS 153 is based on the principle that (with certain exceptions) nonmonetary asset exchanges should be recorded and measured at the fair value of the assets exchanged. It also clarifies how to account for exchanges of productive assets. The new standard is the result of the convergence project between the FASB and the International Accounting Standards Board (IASB) and is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005.
On November 24, 2004, the FASB issued Statement No. 151, Inventory Costs, an amendment of ARB No. 43, Chapter 4 (FAS 151). The standard adopts the IASB view related to inventories that abnormal amounts of idle capacity and spoilage costs should be excluded from the cost of inventory and expensed when incurred. Additionally, the Board made the decision to clarify the meaning of the term “normal capacity“. The provisions of FAS 151 are applicable to inventory costs incurred during fiscal years beginning after June 15, 2005.
Management is considering the effect the above standards will have on adoption.
On December 23, 2003 the FASB released revised FASB Statement No. 132 (FAS 132), Employers’ Disclosures about Pensions and Other Postretirement Benefits. The revised standard is designed to improve disclosure transparency in financial statements. It replaces existing pension disclosure requirements concerning assets, obligations, cash flows, and net periodic costs of defined benefit pension plans and other postretirement benefit
plans.
The requirements of the standard were effective for public entities for fiscal years ending after December 15, 2003.
On January 17, 2003, the FASB issued FASB Interpretation No. 46, (FIN 46 or the “Interpretation”), Consolidation of Variable Interest Entities. FIN 46 was intended to provide guidance in determining (1) whether consolidation is required under the “controlling financial interest” model of Accounting Research Bulletin No. 51 (ARB 51), Consolidated Financial Statements (or other existing authoritative guidance) or, alternatively, (2) whether the variable interest model under FIN 46 should be used to account for existing and new entities. However, the guidance contained in FIN 46 for making such a determination resulted in many more questions than it did answers. As a result in July 2003, the FASB added a limited-scope project to its agenda to modify FIN 46. In December 2003, the FASB released a revised version of FIN 46 (hereafter referred to as FIN 46R) clarifying certain aspects of FIN 46 and providing certain entities with exemptions from the requirements of FIN 46.
In September 2004, the EITF issued EITF 04-10, which addresses how an entity should evaluate the aggregation criteria in paragraph 17 of Statement 131, Disclosures about Segments of an Enterprise and Related Information, when determining whether operating segments that do not meet the quantitative thresholds may be aggregated in accordance with paragraph 19 of Statement 131. The consensus reached was that operating segments must always have similar economic characteristics and meet a majority of the remaining five aggregation criteria, items (a)-(e), listed in paragraph 17, in order to be aggregated under paragraph 19. The consensus should be applied for fiscal years ending after October 13, 2004 with corresponding information for earlier periods, including interim periods, restated unless it is impractical to do so.
The above standards adopted did not have a material impact on the Group.
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| Note 2. Segment and geographic information |
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The Group operates in one segment, which is the business of discovering, developing and commercializing drugs for human health care. The chief operating decision makers review the profit and loss of the Group on an aggregated basis and manage the operations of the Group as a single operating segment. The Group currently derives product revenue from sales of Tracleer for the treatment of pulmonary arterial hypertension and Zavesca for the treatment of Type I Gaucher’s disease. Contract revenue is derived from collaboration and service agreements with third parties. Product revenue attributable to individual countries is based on location of the customer.
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The Group’s geographic information is as follows:
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| December 31, 2004: | | Switzerland | | United States | | Europe | | Other | | Total | |
| Product revenue from external customers | | 7,873 | | 200,058 | | 224,558 | | 22,857 | | 455,346 | |
| Contract revenue from external customers | | 16,534 | | – | | – | | – | | 16,534 | |
| Long-lived assets | | 62,075 | | 3,128 | | 3,818 | | 2,128 | | 71,149 | |
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| December 31, 2003: | | Switzerland | | United States | | Europe | | Other | | Total | |
| Product revenue from external customers | | 6,763 | | 160,760 | | 122,988 | | 9,804 | | 300,315 | |
| Contract revenue from external customers | | 7,229 | | – | | – | | – | | 7,229 | |
| Long-lived assets | | 24,476 | | 1,130 | | 3,812 | | 2,161 | | 31,579 | |
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| Note 3. Axovan |
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On October 31, 2003, the Group acquired Axovan Ltd (“Axovan”), a privately-held biopharmaceutical company in Switzerland focused on the research and development of new compounds. The Group acquired all of the remaining common stock of Axovan for CHF 53 million. The Group acquired Axovan to gain access to Axovan’s licenses and to expand the Group’s research capacities. The acquisition was recorded as a business combination and, accordingly, the purchase price has been allocated to the assets acquired and liabilities assumed based on their estimated fair values at the date of the acquisition. Since the fair value of assets acquired and liabilities assumed exceeded the fair value of the consideration paid the Group then recorded a liability for contingent consideration for the difference.
The Group agreed to pay additional amounts to the shareholders of Axovan upon achievement of future product development milestones. In December 2004, a milestone payment of CHF 32.5 million became payable to former Axovan shareholders upon initiation of a Phase IIb/III clinical trial. This milestone payable was allocated to contingent consideration with the exceeding amount allocated to goodwill. The total additional value of remaining milestone payments could total CHF 146 million. The Group considers all milestone payments to be performance-related measures and as such, treats them as goodwill.
In 2003, the Group has allocated CHF 47 million of the purchase price to in-process research and development projects and other intangible assets with no alternative future use. This allocation represented the estimated fair value based on risk-adjusted cash flows related to the incomplete research and development projects. At the date of the acquisition, development of these projects had not yet reached technological feasibility and the research and development in progress has no alternative future use. Accordingly, these costs were expensed as of the acquisition date.
In making its purchase price allocation, the Group considered present value calculations of income, an analysis of project accomplishments and remaining outstanding items, an assessment of overall contributions, as well as technological and regulatory risks. The value assigned to purchased in-process technology was determined by estimating the costs to develop the acquired technology into commercially viable products, estimating the resulting net cash flows from the projects, and discounting the net cash flows to their present value. The revenue projection used to value the in-process research and development was based on estimates of relevant market sizes and growth factors, expected trends in technology, and nature and expected timing of new product introductions by Axovan and its competitors.
The rates utilized to discount the net cash flows to their present value were based on estimated cost of capital calculations. Due to the risks associated with the projected cash flow forecast, a discount rate of 15% was considered appropriate for the inprocess research and development. The selected rate reflects the inherent uncertainties surrounding the successful development of the purchased in-process technology, the useful life of such technology, and the uncertainty of technological advances that are unknown at this time.
If these projects are not successfully developed, the sales and profitability of the combined companies may be adversely affected in future periods. Additionally, the value of other acquired intangible assets may become impaired. The Group believes that the research and development projects acquired in connection with the acquisition of Axovan are expected to continue in line with the estimates described above.
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| Note 4. Sale of Hesperion |
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On February 9, 2004 the sale of Hesperion to Cerep SA was successfully completed at a total sales price of CHF 16.1 million. Of the total sales price, the Group is entitled to receive CHF 11.1 million for its 69% ownership in Hesperion, resulting in a gain of CHF 9.6 million. The Group has so far received CHF 10 million with CHF 1.1 million remaining in escrow. The escrow balance, which is included in other receivables, will be paid to the Group at the earlier of March 31, 2005 or upon Cerep SA’s approval of Hesperion’s 2004 financial statements. The financial statements as of and for the years ended December 31, 2004 and 2003 reflect Hesperion as a discontinued operation.
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| Note 5. Licensing agreements |
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On March 19, 1998, the Group entered into a license agreement with F. Hoffman-La Roche (“Roche”) for tezosentan. Under this agreement, Roche granted the Group an exclusive worldwide right to manufacture and sell any product with tezosentan as its active ingredient. The license covers any human therapeutic use of tezosentan except acute renal failure and subarachnoid hemorrhage. The Group may also grant sub-licenses to third parties. The agreement called for the Group to make an initial payment to Roche as well as payments upon the achievement of certain milestones. The Group will make milestone payments upon the filing and approval of new drug applications in the United States and the European Union. If the Group is successful in obtaining regulatory approval for Veletri, the Group will pay a royalty to Roche based on a percentage of net sales of products with tezosentan as the active ingredient. No payments were made under this agreement during 2004 and 2003.
On November 4, 1998 the Group entered into a license agreement with Roche for bosentan, the active ingredient in the Group’s product, Tracleer. The license grants the Group the exclusive worldwide rights to develop, manufacture, sell any pharmaceutical product with bosentan as its active ingredient for any human therapeutic use, and grant sub-licenses to third parties. The agreement called for the Group to make an initial payment to Roche as well as payments upon the achievement of certain milestones. All payments made to Roche prior to receiving regulatory approval were expensed as acquired in-process research and development costs. Payments made to Roche subsequent to receiving regulatory approval were capitalized and are being amortized over the life of the agreement. As of December 31, 2004 and 2003, payments of CHF 9 million are included in intangible assets and are amortized over 11 years. The agreement also calls for the Group to pay a royalty to Roche based on a percentage of net sales of products with bosentan as the active ingredient.
On November 22, 2002 the Group entered into a license agreement with Oxford GlycoSciences (“OGS”) for miglustat, the active ingredient of Zavesca. OGS has since been acquired by Celltech Group plc which was subsequently acquired by UCB SA. In 1998, OGS in-licensed miglustat from G.D. Searle & Co. Under the Group’s license agreement with OGS, the Group has been grant ed exclusive marketing rights to sell Zavesca in all countries except Israel and the adjacent West Bank and Gaza Strip territories. For the period from January 1, 2003 through the expiration of the agreement, the Group will pay Celltech a royalty on net sales of Zavesca. The agreement also provides that Celltech is the Group’s sole supplier of Zavesca.
In conjunction with the acquisition of Axovan on October 31, 2003 the Group gained access to the license granted from Roche for Clazosentan. In June 2004, the Group incurred a CHF 5 million inprocess research and development charge in form of a milestone payment to Roche relating to this agreement.
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| Note 6. Collaborative agreements |
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In July 1999, the Group entered into an agreement with a subsidiary of Johnson and Johnson (“J&J”). For the first three years of the agreement, J&J paid the Group for certain research and development costs incurred under the agreement. In October 2003, the agreement was amended to the effect that the Group would be the best place to continue development of the compounds covered by the collaboration. The Group therefore, has now sole rights for the ongoing development and potential commercialization of these compounds.
If successful, the Group will pay J&J a small royalty on sales generated from these compounds. In February 2000, the Group entered into an agreement with Genentech Inc. (“Genentech”) for the co-exclusive, royalty-bearing right and license to research, develop, manufacture and sell tezosentan in the United States. Genentech may elect to co-promote the drug for certain indications in the United States or receive a royalty on net sales of tezosentan in the United States. Upon signing the contract the Group received an upfront payment, which is being recognized over the life of the agreement.
For each of the years ended December 31, 2004 and 2003 the Group recognized revenue of CHF 1.5 million related to this agreement. In December 2000, the Group entered into an agreement with Genentech for the co-exclusive, royalty-bearing right and license to research, develop, manufacture and sell bosentan, the active ingredient in Tracleer, in the United States. Genentech receives a royalty on net sales of bosentan in the United States. Upon signing the contract the Group received an upfront payment, a portion of which was refundable if the Group did not complete Phase III trials for bosentan for use in the treatment of chronic heart failure. The non-refundable portion of the upfront payment is being recognized over the agreement period, which began in December 2000. In December 2001, the Group received FDA approval for bosentan in the United States for the treatment of pulmonary arterial hypertension and began paying Genentech a royalty on net sales. In January 2002, the Group completed Phase III trials for bosentan for the use in the treatment of chronic heart failure and received neutral results. Upon completion of Phase III trials and receipt of the neutral results, the Group began recognizing the refundable portion of the upfront payment over the remaining agreement period. For each of the years ended
December 31, 2004 and 2003 the Group recognized revenue of CHF 4.9 million related to this agreement.
In December 2003, the Group and Merck & Co., Inc. (“Merck”), formed an exclusive worldwide alliance to discover, develop and market new classes of renin inhibitors. This alliance enables the Group and Merck to combine their discovery, development and marketing capabilities with the goal to efficiently provide innovative and better medicines to patients suffering from cardio-renal diseases. Development funding will be initially shared by both parties, with Merck fully responsible to fund pivotal Phase III and outcome studies. Merck will lead and fund commercialization. The Group retains a worldwide option to co-promote any product resulting from this alliance as a paid-for sales force. Merck made an upfront payment of USD 10 million and USD 15 million following completion of technology transfer to Merck. In addition, the Group will be eligible to receive additional payments of up to USD 247 million for the successful commercialization of the first collaboration product. The Group will also be eligible to receive certain milestone payments for the successful commercialization of additional products. Merck will pay the Group substantial royalties on the sale of all products resulting from this alliance. For the years ended December 31, 2004 and 2003, the Group recognized revenue of CHF 9.9 million and CHF 0.3 million, respectively, under this agreement.
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| Note 7. Income taxes |
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The following table sets forth the income before taxes:
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| For the Year Ended December 31, | |
| | | 2004 | | 2003 | |
| Switzerland | | 79,249 | | 19,287 | |
| Foreign | | 2,598 | | (19,823) | |
| Total income before taxes | | 81,847 | | (536) | |
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The following table sets forth the current and deferred income tax expense:
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| | | For the Year Ended December 31, | |
| | | 2004 | | 2003 | |
| Current tax expense: | | | | | |
| Switzerland | | 60 | | 105 | |
| Foreign | | 7,169 | | 725 | |
| Total current tax expense | | 7,229 | | 830 | |
| Deferred tax (benefit) expense: | | | | | |
| Switzerland | | (2,953) | | – | |
| Foreign | | – | | – | |
| Total deferred tax (benefit) expense | | (2,953) | | – | |
| Total income tax expense | | 4,276 | | 830 | |
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Taxes payable and accrued as of December 31, 2004 amounted to CHF 6.6 million (2003: CHF 0.6 million). Significant components of the Group’s deferred tax assets as of December 31, 2004 and 2003 are shown below. A valuation allowance of CHF 27.7 million (2003: CHF 42.6 million) has been recognized for certain Group companies based on their historical cumulative operating losses.
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| | | 2004 | | 2003 | |
Deferred tax assets:
Net benefit from operating
loss carryforwards | |
24,924 | |
29,909 | |
| Deferred revenue | | 3,317 | | 6,927 | |
| Other temporary differences | | 4,677 | | 5,794 | |
| Total deferred tax assets | | 32,918 | | 42,630 | |
| Valuation allowance for deferred tax assets | | (27,662) | | (42,630) | |
| Net deferred tax assets | | 5,256 | | – | |
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The gross value of unused tax loss carry forwards with their expiry dates is as follows:
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| | | Not capitalized | | Capitalized | | Total 2004 | |
| One year | | – | | – | | – | |
| Two years | | 780 | | – | | 780 | |
| Three years | | – | | – | | – | |
| Four years | | 1,504 | | – | | 1,504 | |
| Five years | | 6,844 | | 2,811 | | 9,655 | |
| Six years | | 6,446 | | 9,719 | | 16,165 | |
| Seven years | | 12,705 | | – | | 12,705 | |
| More than seven years | | 40,054 | | – | | 40,054 | |
| Total | | 68,333 | | 12,530 | | 80,863 | |
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|
|
Reconciliation between the effective income tax expense and the Swiss statutory tax rate, which is 25%:
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|
| |
| |
|
| | | 2004 | | 2003 | |
| Tax at Swiss statutory rate of 25% | | 20,462 | | (134) | |
| Non deductible expenses, | | | | | |
| non taxable income | | (533) | | 8,099 | |
| Different effective tax rates | | (9,281) | | (1,365) | |
| Utilization of unrecognized tax losses | | (8,280) | | – | |
| Change in valuation allowance | | 3,224 | | (5,702) | |
| Prior year adjustments and other items | | (1,316) | | (68) | |
| Effective income tax expense | | 4,276 | | 830 | |
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| Note 8. Earnings per share |
| |
Earnings per basic and diluted share are based on weighted average common shares and exclude anti-dilutive shares relating to employee stock options of 601,324 for the year ended December 31, 2004 and excludes diluted shares of 1,100,407 for the year ended December 31, 2003 as they would be anti-dilutive due to the reported loss in 2003. The following table sets forth the basic and diluted earnings per share calculation:
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| |
|
| | | 2004 | | 2003 | |
| Income (loss) on continuing operations | | 77,571 | | (2,455) | |
| Gain (loss) on discontinued operations | | 9,648 | | (7,461) | |
| Net income (loss) | | 87,219 | | (9,916) | |
| Weighted average number of shares outstanding | |
22,017,656 | |
21,567,195 | |
| Basic income (loss) per share of continuing operations | |
3.52 | |
(0.11) | |
| Basic income (loss) per share of discontinued operations | |
0.44 | |
(0.35) | |
| Basic income (loss) per share of net loss | | 3.96 | | (0.46) | |
| | | | | | |
| Weighted average number of shares outstanding | |
23,051,406 | |
22,667,602 | |
| Diluted income (loss) per share of continuing operations | |
3.36 | |
(0.11) | |
| Diluted income (loss) per share of discontinued operations | |
0.42 | |
(0.35) | |
| Diluted income (loss) per share of net income | | 3.78 | | (0.46) | |
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| Note 9. Cash and cash equivalents |
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Cash and cash equivalents consisted of the following at December 31:
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| | | 2004 | | 2003 | |
| Cash | | 111,040 | | 154,385 | |
| Short-term bank deposits | | 184,138 | | 102,932 | |
| Money market funds | | 5,158 | | 1,453 | |
| Total | | 300,336 | | 258,770 | |
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| Note 10. Investments |
| |
Marketable Securities
During September 2003, management changed its investment strategy and decided to sell investments of CHF 11.8 million previously classified as held-to-maturity for a realized gain of CHF 409,676. In accordance with US GAAP, as a result of selling these investments prior to their maturity, the Group is precluded from classifying any security as held-to-maturity until 2006. At December 31, 2004 the Group maintained no investments in marketable securities.
Financial Instruments
The following tables show the contract or underlying principal amounts and fair values of derivative financial instruments at December 31, 2004 and 2003. Contract or underlying principal amounts indicate the volume of business outstanding at the balance sheet date and do not represent amounts at risk. The fair values are determined by the markets or standard pricing models at December 31, 2004 and 2003, respectively.
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| |
| |
|
Derivative financial instruments
| | Contract or
underlying principal amount | | Positive
fair values | | Negative fair
values | |
| 2003 | | | | | | | |
| Foreign exchange rate options | | 49,979 | | 1,942 | | 2 | |
| Forward foreign exchange rate contracts | | 10,335 | | 257 | | – | |
| Total | | 60,314 | | 2,199 | | 2 | |
| | | | | | | | |
| 2004 | | | | | | | |
| Foreign exchange rate options | | 58,182 | | 1,024 | | 64 | |
| Forward foreign exchange rate contracts | | 63,597 | | 1,398 | | 328 | |
| Total | | 121,779 | | 2,422 | | 392 | |
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| Note 11. Trade and other receivables |
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Trade and other receivables consisted of the following at December 31:
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| | | 2004 | | 2003 | |
| Trade receivables | | 100,885 | | 62,594 | |
| Other receivables | | 8,764 | | 4,117 | |
| Total | | 109,649 | | 66,711 | |
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|
In 2004 the Group recorded a bad debt allowance of CHF 0.16 million.
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| Note 12. Inventories |
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Inventories consisted of the following at December 31:
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| | | 2004 | | 2003 | |
| Intermediaries | | 14,132 | | 18,331 | |
| Finished products | | 3,771 | | 3,124 | |
| Total | | 17,903 | | | |
